Demystifying Initial Coin Offering

The no-holds-barred philosophy of “asking for forgiveness as opposed to permission” reigns in bitcoin-land where developers write software and entrepreneurs build businesses first without seeking the regulator’s approval.

While this turns out to be fine sometimes, other times bright-eyed experimenters may end up finding that the legal gray area in which they believed to have been operating was actually more black than white. Using cryptocurrency does not mean that you are out of the reach of law enforcement. Indeed, Ripple, Erik Voorhees, Charlee Shrem and Trendon Shavers are among those that have found out that the law can still come crashing on you if you do something unlawful.

Initial Coin Offering (ICO) is one of the legally murky aspects of the crypto world. An ICO is used by business people and developers to collect money from people who are keen on investing in a new venture. Interested investors usually send bitcoins to the development team that is making the ICO in exchange for a new type of digital tokens such as altcoin or appcoin. The idea is that these digital tokens will be tied to the success of a particular project or business. It is expected that the growth of the project will translate to the increase in the value of the token purchased at the ICO.

There are questions about the legality of the ICO concept. For instance, it is not clear whether the purchase of ICO tokens results in creation of a security which, in countries such as the U.S, would require registration with the Securities and Exchange Commission. Technologists and entrepreneurs who raise money through the internet by the apparently unregulated token sales would find themselves in trouble if the authorities determine that the tokens are securities.

So far, the largest ICO is the Distributed Autonomous Organisation (DAO) that was built on the ethereum platform. The DAO was designed to be a venture capital fund without any barrier to entry. Several cryptocurrency projects have failed over the years but the DAO implosion remains one of the most spectacular. A hacker successfully redistributed funds to himself through a flaw in DAO smart contract. The debacle led the ethereum community to abandon its “code is law” mantra and alter the ethereum ledger to allow DAO token holders to reclaim the money that they had deposited.

Today, most ICOs are launched on top of ethereum whose smart contracting system makes launching these projects quite easy. Ethereum was itself launched in 2014 in an ICO where investors exchanged bitcoins for a token referred to as ether. Currently, ether’s market capitalization stands at $1.7 billion.

Jason Seibert, a U.S securities lawyer has come to the conclusion that the ether ICO was by all standards an issuance of a security because, just like in any other security, people who purchased ether did so with the expectation of making a profit in future. In fact, Vitalik Buterin, the creator of ethereum stated in a March 2014 interview that he expected a fivefold increase in the price of ether after initial presale.

However, opinion has been divided on whether digital assets should be treated as securities as demonstrated by a 2016 report by Coin Centre, a think tank in Washington. The report recommended that ether should not be considered as a security as people who purchased it were doing so to use the ethereum network and not simply for profit.

As can be seen, the decision as to whether digital assets should be treated as securities turns on whether the buyers expect a profit. Once this point is settled, the legal implications are set to change.